China-Hong Kong "bond connect" has dual benefits

Investors laugh in front of an electronic screen showing stock information at a brokerage house in Nantong, Jiangsu province, November 24, 2014. Chinese stocks rose, with a key index hitting a three-year high, while bond yields fell on Monday.China Daily

HONG KONG (Reuters Breakingviews) - China's plan to allow Hong Kong and mainland investors to trade each other's debt is good news for the Special Administrative Region. By making it easier for foreigners to trade onshore bonds, the tie-up means Chinese debt is more likely to join benchmark global indexes. And allowing Chinese investors into Hong Kong's fixed income market will deliver a fresh source of liquidity. Both results will benefit Hong Kong's financial industry.

Plans for a "bond connect" programme have been percolating since Beijing launched schemes allowing two-way trading between Hong Kong's stock market and bourses in Shanghai and Shenzhen. However, soft economic data, a weakening currency, and tighter capital controls have made most foreign fund managers wary of holding yuan assets.

But signs of economic warming have some fund managers wondering whether they may be unduly underweight China. Citigroup recently incorporated Chinese sovereign bonds into a few smaller indexes, but China wants them included in major international benchmarks, which could induce passive funds that track them to redeploy hundreds of billions of dollars.

The government already allows institutions direct access to its primary onshore bond market, but some foreign managers are wary of setting up shop on the mainland given concerns about its onerous regulatory environment. A bond connect would allow them to set up shop in Hong Kong instead.

For mainland investors, Hong Kong dollar-denominated bonds could help hedge against currency risk and rising global interest rates. Chinese funds began aggressively moving into Hong Kong stocks via the connect programmes in February. If such enthusiasm were replicated via a bond connect, the city's fixed income market - which had a modest HK$1.5 trillion ($193 billion) outstanding at the end of 2015 - could get a decent boost.

So far the plans are short on specifics, and details on things like quotas, profit remittance and taxation will matter a great deal. But if Beijing gets the details right, Hong Kong will be the winner.

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